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Is the Wealth Gap Hurting all of Us?

In his new book, Nobel Prize-winning economist and Columbia Business School professor Joseph Stiglitz argues that growing inequality and economic unfairness could threaten the stability of the country in the long run.

His book, "The Price of Inequality," illustrates how the American economy has been engineered to benefit a few while taking from everyone else -- and why that's a problem. He also lays out ways to reduce the increasing wealth gap in society.

Bankrate spoke with Stiglitz about his new book.

Why does growing inequality matter? After all, we have all heard that people who are poor, they are poor for a reason. And people get rich because they work really hard.

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We care about inequality partly because we pay a high price in terms of our economic performance. We care about it also because of the impact that it has in every other aspect of our society -- our democracy, our rule of law, our sense of identity or a land of opportunity -- because we aren't anymore.

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The people at the top are not the people who made the most contributions to our society. Some of them are. But a very large proportion (is) simply people I describe as rent-seekers -- people who have been successful in getting a larger share of the pie rather than increasing the size of the pie.

Could you explain rent-seeking?

Rent is a return on income that you get not as a result of your contribution but because of your ownership of land. It was a notion that income does not have to rise out of effort or making a contribution.

But economists have generalized that to a much broader usage, which really includes any kind of activity, which is more directed at redistributing the existing pie nationally rather than enhancing national income.

The term got used a lot in the context of, say, Middle East oil countries or developing countries where there are natural resources and people fight over who gets claims on those natural resources.

While we look at these economies, these oil, mineral, resource-rich countries as distorted and think, "Oh, that is a problem of poor developing countries," we don't understand the extent to which our economy has really become a rent-seeking economy.

How has the financial sector contributed to the growing inequality?

Much of what goes on in the financial sector is this kind of rent-seeking.

The most dramatic example was the predatory lending and the abusive credit card practices, which took money from people on the bottom and the middle often in a very deceptive way, sometimes in a fraudulent way, and moved it to the top.

That is a case where they both affected two of the more important dimensions of our inequality, that is to say, the suffering of those at the bottom and the wealth of those at the top.

I don't want to say it was totally the banks but, in part, (they were) pushing mortgages that were inappropriate for these individuals. (Banks were) pushing them because they generated lots of fees and transaction costs that they were focusing on. (Banks were) not focusing on what would be appropriate for the customers. They were the experts who were supposed to make a judgment about risk management. And obviously, that wasn't what they were doing.

There is another example where the financial sector has been particularly bad. They pushed for laws like our bankruptcy laws that gave priority to derivatives. In bankruptcy, derivatives got protected and workers and everybody else has to swallow their losses. That encourages more risk-taking.

At the same time, they pushed for laws that made it more difficult for ordinary Americans to discharge their debt and (were) particularly bad for students who can't discharge their debt no matter what happens, no matter how they have been deceived by the schools, even in the event of bankruptcy.

What has been the Fed's role in growing inequality?

It has had several roles. One is related to what we have just been talking about on the banking system. They will champion this view. You shouldn't regulate banks. You should let the banks get away with predatory lending, anti-competitive practices, abusive credit card practices, risk taking. Don't try to encourage them to go into lending that would create jobs, but just let them do what they want to do.

They have been, in a sense, a champion of the interest of the banks.

That is one side.

The other side is that they have had an excessive focus on inflation. Not enough focus on unemployment. And that has meant that they didn't focus on stability. They didn't focus on how we get the financial sector to do more lending, they just focused on inflation. And, of course, inflation could be an important problem and hasn't been for the last 30 years.

And in some sense, focusing on the problem in the past and not focusing on today's problem led to higher unemployment. And this high level of unemployment is now affecting inequality in three ways. First, those who are unemployed are obviously sinking to the bottom. Second, high levels of unemployment put downward pressures on wages. And third, the high level of unemployment means government revenues are lower, and that means fiscal cutbacks, which are particularly painful for those in the middle and the bottom.

How should the financial sector be reformed?

I think the answer is: You begin by saying, "What is the financial sector supposed to do?" It is supposed to be serving the rest of the economy.

It is supposed to allocate capital, manage risk. It is supposed to provide funds to small and medium-sized enterprises. So focus on what it is supposed to do. Then, you look at what it does and you say, "Well, let's curtail the things that they're doing and that will encourage them to do what they should do."

For instance, if we restricted their ability to write these CDS derivatives (credit default swaps) -- from which they make so much money -- if we restricted their ability to engage in gambling like JPMorgan did, that would encourage them go to into sound lending practices.

If we restricted their ability to use anti-competitive practices to make money out of credit cards and by abusive credit card practices; if we restrict them from doing all the bad things they were doing, we will hopefully encourage them go to go back to the core mission of banking and that will make our economy stronger.

How else can the government act to reverse this trend in inequality?

Inequality in the United States has many dimensions; too much money at the top, many people in poverty, the hollowing out of the middle class. And each of these requires its own solution.

We have to have a more progressive tax structure. And what is interesting to realize is that our tax structure not only is unfair, but actually distorts our economy. It lowers growth and increases inequality. If you tax speculation at less than half the rate you tax people who work for a living, what you do is you encourage speculation. You weaken the economy. Speculative activities are activities associated with high levels of inequality. And that way you increase inequality.

We tax in a sense a lot of the rent-seeking activities at a lower rate because they get under the rubric of the capital gains tax. With our lack of progressivity, we are encouraging rent-seeking activities. So much of the money at the top is rent-seeking. When you tax it lower, you actually are encouraging rent-seeking.

So, those are examples of the kinds of things that we could do that would simultaneously make our economy more dynamic, more efficient, grow faster and less unequal.